Savings Allowance- problems and pitfalls?
The new savings allowance rules are nearly here, yet a recent study by AA Financial Services, found that 90% of savers still didn’t know what the new allowance was, and after having it explained to them, 49% of respondents said they didn’t know what to do with their money come April. The major problem being the choice between ISAs and savings accounts.
Previously, we have chuntered on about how, when cash ISA rates are low, the banks are been essentially taking advantage of the tax-free status of ISAs to offer lower rates than on standard savings accounts- but that are higher net because of the lack of 20% tax deducted at source. Once tax deduction at source stops on 6 April, however, cash ISA rates need to be directly comparable to savings rates in order to be attractive. But are they?
From moneyfacts.co.uk, one year fixed rates for ISAs come in at approximately 1.35% to 1.45%. Compare these rates with those available for regular savers (where you save around £25-£250 per month) and even current account rates, which can achieve up to 4% or 6% and it doesn’t look good for ISAs. Of course you may already have a sizeable cash ISA pot, and these higher rate accounts will have deposit limits, so if you have a large pot, then retaining the excess over your savings allowance in a tax-protected vehicle like an ISA might be a wise move.
But in another confusing twist, if you have a reasonable amount of other income, you might want to get a lower rate of interest on your savings.
The problem is that the new allowance is a two tier system- you are either a higher rate taxpayer or a basic rate one, and the amount of the allowance depends on that- even if you are only just into the 40% band.
If you earn just under the current (2016/17) 40% band, say £42,000, a difference of 0.2% in interest rate could mean they get less overall. If you had £60,000 savings earning 1.8%, that would generate £1,080 interest, giving total income of £43,080. As a higher rate taxpayer (by £80), only £500 of the interest would be tax free and the remaining £580 would be subject to tax.
But if the rate on that £60,000 were only 1.6%, the interest would be £960, which is less interest, but it is all tax free; as a basic rate taxpayer (total income £42,960) the savings allowance is £1,000, meaning you’d actually be better off (marginally) with a lower rate of bank interest. A similar (but more sheer) difference occurs at the higher rate/additional rate threshold.